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Public Finance & Taxation Chapter -3- Public Finance in Ethiopia

Chapter Three

3. Public Finance in Ethiopia

3.1. Features of Ethiopian Federal Finance

Ethiopia is a federal state which comprises of a central government and nine Regional

Governments. There are also two chartered cities. As a federal country, the functions and duties

of the government are divided between central and state governments and they are generally

defined in the constitution.

Federalism requires decentralization of government decision-making and implementation

involves delegating more power to the decentralized divisions of the government. The goal of

this strategy is to speed up government action and to deliver a more suitable package of services

needed by the locality. One component of federalism is fiscal federalism which gives local

governments some taxing power and expenditure responsibility, and allows them to decide on

the level and structure of their expenditure budgets. The main goal of fiscal decentralization is to

move governance closer to the people, and this does require strengthening local government

finances. Fiscal decentralization requires local governments with some autonomy to make

independent fiscal decisions.

Fiscal federalism has four components:

 Revenue Assignment

 Expenditure Assignment

 Intergovernmental Transfer (subsidy)

 Borrowing

3.1.1. Revenue Assignment

The division of taxation power is a principal aspect of the Constitution that provides the legal

framework of the Ethiopian federal system. The Constitution divides the taxation power into

three categories, namely ‘the federal power of taxation’, ‘the state power taxation’ and ‘the

concurrent power of taxation’.

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The distribution of revenues between the center and states is followed on the basis of

"Constitution of Ethiopia‛ and Proclamation No. 33/1992-Proclamation ‚To Define sharing of

Revenue between the Central Government and the Regional Self Governments‛. The Articles 96,

97, 98, 99 and 100 of The Constitution of Ethiopia make a clear demarcation of areas where the

Central alone or State alone have authority to impose taxes. It contains a detailed list of the

functions and financial resources of the Center and States.

Objectives of Revenue sharing:

The sharing between the central government and the Regional

A government has the following objectives:

 To enable the central Government and the Regional Governments efficiently carry out

their respective duties and responsibilities.

 To assist Regional Governments develop their regions on their own initiatives;

 To narrow the existing gap in development and economic growth between regions;

 To encourage activities those have common interest to regions.

Basis for Revenue Sharing:

The sharing of revenue between the central government and the

National/ Regional governments take in to consideration the following Principles:

 Ownership of source of revenue;

 The National or Regional character of the sources of revenue;

 Convenience of levying and collection of the tax or duty;

 Population, distribution of wealth and standard of development of each region;

 Other factors that are basis for integrated and balanced economy.

Categorization of Revenue:

According to "Constitution of Ethiopia‛ revenues are categorized as Central, Regional and Joint.

The following are Federal Taxes:

 Duties, tax and other charges levied on the importation and exportation of goods;

 Personal income tax collected from the employees of the central Government and the

international Organizations;

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 Profit tax, Personal income tax and sales tax collected from enterprises owned by the

Central Government. (Now sales tax is replaced with VAT and Turnover taxes).

 Taxes collected from National Lotteries and other chance winning prizes;

 Taxes collected on income from air, train and marine transport activities;

 Taxes collected from rent of houses and properties owned by the central Government;

 Charges and fees on licenses and services issued or rented by the central Government;

The following are Taxes of Regional Government:

 Personal income tax collected from the employees of the Regional Government and

employees other than those covered under the sources of central government.

 Agricultural income tax collected from farmers not incorporated in an organization.

 Profit and sales tax collected individual traders.

 Tax on income from inland water transportation.

 Taxes collected from rent of houses and properties owned by the Regional Governments;

 Profit tax, personal income tax and sales tax collected from enterprises owned by the

Regional Government:

 Income tax, royalty and rent of land collected from small scale mining activities.

 Rural land use fee.

 Charges and fees on licenses and services issued or rented by the Regional Government;

The following are Joint Taxes:

 Profit tax, personal income tax and sales tax collected from enterprises jointly owned by

the central Government and Regional Governments;

 Profit tax, dividend tax and sales tax collected from Organizations;

 Profit tax, royalty and rent of land collected from large scale mining, any petroleum and

gas operations;

 Forest royalty

Collection and Allocation of Joint Revenues: It is the federal government which collects both the

federal and joint revenues. The joint revenue is shared based on a decision made by a committee

appointed by the prime minister and consisted of representatives of both levels of governments.

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The following table shows how the joint revenue is shared between the federal government and

regional government.

Jointly Established Enterprises Federal Government Regional Government

Profit Tax In proportion to their respective capital contribution
Employment Income Tax 50% 50%
Value-added Tax 70% 30%
Turnover Tax 70% 30%
Excise Taxes 70% 30%
Profit Tax 50% 50%
Dividend Income 50% 50%
Value-added Tax 70% 30%
Turnover Tax 70% 30%
Excise Taxes 70% 30%
Mineral & Petroleum Operation
Profit Tax 50% 50%
Royalty 60% 40%

Undesignated Power of Taxation: The power of taxation mentioned in the Constitution is not

exhaustive. To avoid unnecessary dispute between regional governments and the federal

government when a new taxable activity emerges, Article 99 of the constitution states that ‘The

House of Federation and the House of peoples’ Representatives shall, in a joint session,

determine by a two-thirds majority vote on the exercise of powers of taxation which have not

been specifically provided for in the constitution.’

3.1.2. Expenditure Assignment

The federal structure of Ethiopia allocates functions and responsibilities, and hence expenditure,

to federal government and regional governments. Art 51 of the Constitution entrusts the federal

government with power subject to national defense, international or foreign relations,

citizenship, immigration and naturalization; interstate commerce, postal and telecommunication

services, weights and measures, domestic currency coinage and foreign currency usage, banking,

patents and copyrights, operation of air, rail and water transports and highways linking two or

more states, enacting labor, electoral, procedural, criminal, and commercial codes. Art 52 (2)

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assigns to regional governments such power and functions as enacting and executing the state

constitutions; establishing state police, maintaining public peace and order; administration of

land and other natural resource within the region; and formulating and executing economic,

social and development policies, strategies and plans of the state. The states also have power

over areas of education, health and agriculture. Both regional governments and federal

government are required to cover expenditure to be incurred in connection with their respective

functions and responsibilities. The following table shows the expenditure assignment to the three

levels of government.

Level of Government Expenditure Assignments

 Defense
 Foreign relations
 Justice and internal security
 Macro stabilization
 International trade
 Currency and banking
 Immigration
 National interest capital projects
 Shared with regions: environment, airlines, and railways
 Secondary education and colleges
 District and referral hospitals
 Nursing schools
 Water supply
 Regional and zonal roads
 Regional police
Regional  Maintenance of irrigation systems
Government  Maintenance of smaller-scale water supply projects and energy
 Agricultural planning
 Shared with federal: justice, environment, police, and vocational
and preparatory schools

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 Primary education
 Basic health care
 Agricultural extension programs
 Veterinary clinics
 Land use administration
Woreda  Water development, wells construction and maintenance
 Local police
 Local roads
 Shared with regions: small-scale capital projects

3.1.3. Intergovernmental Transfer (subsidy)

Intergovernmental transfers refer to the transfer of money from central government to regional

governments. It has been employed in all federations to achieve a variety of economic objectives.

In Ethiopia the transfer is in the form of subsidy. The main objectives of subsidy in Ethiopia are:

1. offsetting fiscal imbalances or closing fiscal gaps;

2. establishing horizontal equity across the federation and

3. offsetting inter-jurisdictional benefit spillovers or for merit good reasons

Fiscal Imbalances: An important reason for giving transfers arises from fiscal imbalances or

mismatch between revenues and expenditures of different governmental units. Fiscal imbalances

can be ‚vertical‛ or ‚horizontal‛. ‚Vertical fiscal imbalance‛ refers to the difference between

expenditures and revenues at different levels of government, and ‚horizontal fiscal imbalance‛

refers to the differences between revenue and expenditure levels within a particular level of


Fiscal Equity: The argument for intergovernmental transfers on equity grounds has been made

either in terms of ensuring horizontal equity of individuals across the states, or simply of

ensuring inter-regional equity. Both the approaches build a case for unconditional or general

purpose transfers from the center to the states on a progressive scale so as to offset the fiscal

disabilities arising from low revenue capacity and high expenditure needs.

Correction of spillovers: Intergovernmental transfers are seen as a device to resolve the problem

of mismatch between benefit spans from various hierarchies of public goods and exogenously

given spatial jurisdictional domains. When the benefits of public services provided by a state

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spill over its jurisdiction, the state ignores the benefits accruing to the non-residents while

deciding the amount of the service provided. The jurisdiction equates the marginal benefits from

the public service with the marginal cost of providing it, and as it ignores the part of the benefit

accruing to non-residents the result is non-optimal provision of the public service. Optimal

provision of the service is ensured through central subsidies to offset the spillovers.

As can be evidently observed from the revenue and expenditure assignments addressed in the

Constitution, the lucrative (profitable) sources of revenue in Ethiopia are assigned highly to the

federal government while a wide range of expenditure responsibilities are reserved to the

regions. The subsidy from the federal government to the regional government is made based on a

formula approved by the House of Federation.

3.2. Borrowing

Regional governments are not allowed to borrow from abroad. It is the federal government that

has the power to borrow from abroad. They can, however, borrow internally from banks to meet

the cash flow timing problem. Borrowing internally from banks requires the permission of

MOFED. When regional governments experience budget shortfall in any fiscal year the federal

government may give them loan in the form of advance to be charged to their budgetary subsidy

of the following year.

3.3. Ethiopian Public Finance

Source of Government Finance

Domestic Revenue
 Tax Revenue
 Non-Tax Revenue
 Capital Revenue
External Assistance
 Multilateral Institutions
 Bilateral Assistance
 Counter Part Fund Assistance
External Loans and Credits
 Multilateral Institutions
 Bilateral Loan
 Counter Part Fund Loan
Domestic Borrowing

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3.3.1. Public Revenue

Public revenue refers to different sources of government’s income. The Ethiopian government

revenue is broadly divided into three: tax revenue, non-tax revenue, and capital revenue. The tax

revenue includes income taxes, VAT, TOT, excise tax, custom duty, and stamp duty. The non-tax

revenue includes

 Administrative fees and charges: passports & visas, registration of foreigners, work permits,

court fines, court fees, forfeits, business and professionals registration fee, license fees,

warehouse fees, television license fees, coffee inspection & other fees, standards charges, other

fees and charges,

 Sales of public goods & services: sales of government newspapers, magazines & publications,

media, advertising revenue, health services, sales of medicines &medical supplies, medical

examinations & treatments, handicrafts, printed forms, prisons administration revenue,

research and development services, vocational and educational institutions, entertainment,

engineering industry cultural services meteorological services mapping services civil

aviation services road transport services; science &technology services; national examination

services; farm products; forest products; and other goods and service

 Government investment income: residual surplus; dividend income from government assets;

national lottery surplus; interest on loan to government agencies; interest on loan to

government employees; interest on government bank accounts; capital charges; lease of land

 Miscellaneous revenue: pre-shipment inspection fee; sales of stamps and others

Capital revenue: sales of moveable and immovable properties; privatization proceeds; collection

of principal from on-lending.

The government receives grants from foreign governments and other developmental

organizations. The grant may be in cash or in-kind. The grant and assistance may be obtained

from multilateral institutions (such as African Development Fund, European Union, Food and

Agricultural Organization, International Development Association, UNICEF, United Nations

Development Program, United Nations Fund for Population Activity, World Health

Organization), bilateral (grant from countries), and debt relief assistance.

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3.3.2. Public Expenditure

Since the modern government represents a welfare state, the responsibility of the government is

to bring about maximum social welfare. In addition to this, it has to perform various other

functions, which require heavy expenditures. Public expenditure refers to the expenses, which

the government incurs for its own maintenance as also for the society and the economy as a

whole. Classifying expenditures is important in policy formulation and the identification of

resources allocation among sectors. An expenditure classification system provides a normative

framework for both policy decision making and accountability. The best-known classification

systems are the functional ‚Classification of the Functions of the Government (COFOG),‛

developed by the United Nations, and the Government Financial Statistics (GFS) classification,

developed by the IMF. Expenditures are classified for different purposes, such as: the

preparation of reports that fit the needs of report users (policy decision makers, the public, and

the budget manager); the administration of the budget and budgetary accounting; and the

presentation of the budget to Parliament.

According to the different needs for policy formulation, reporting and budget management

expenditures are classified according to the following categories:

 function, for historical analysis and policy formulation;

 organization, for accountability and budget ration;
 economic category, for statistics (GFS)
 object (i.e., line item), for compliance controls and economic analysis;
Classification by Function: A functional classification organizes government activities according

to their purposes (e.g., education, defense, health, social security, housing, etc.). It is independent

of the government organizational structure. A functional classification allows analyzing the

allocation of resources among sectors. It also allows producing historical surveys of government

spending and comparing data from different fiscal years.

Line-item classification: For budget management purposes, the budgets include an object

classification (also called ‚line-item classification‛). This line-item classification lists expenditures

along categories used for budgetary control and monitoring, such as different categories of

personnel expenditures, travel expenses, printing.

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Administrative classification: Public expenditures can be classified based on governmental

organization. Expenditures are classified into separate sections for each ministry, department, or

agency. It is used for clear identification of responsibilities in public expenditure management

and also for day-to-day administration of the budget.

Economic classification: Public expenditures are classified into recurrent expenditure, capital

expenditure, interest payment, and repayment of loan. Recurrent expenditure covers all items to

be funded during the current fiscal year like salaries, materials, and services necessary for the

ongoing activities. Capital expenditure refer to the cost of acquiring buildings, roads, dams,

equipment and other items that will have a life-span of more than 1 year.

Even if the government expenditure is broadly classified into recurrent and capital expenditure,

expenditures are also classified based on functions. The major classification is into general

services, economic services, social services, pension payments, interest & charges, subsidies, and

external assistance. The following table shows what is included under the major functions.

General Services Economic Services Social Services

Organ of the State Agriculture & Natural Resource Education & training
Justice Trade & Industry Culture & sports
Defense Mines & Energy Public health
Public order & security Tourism Labor & social welfare
General services Transport & communication Rehabilitation
Urban development & construction
Economic development studies

3.3.3. Public Debt

It is obvious that when any government's expenditure exceeds its revenue, then this deficit will

be financed either by internal or external borrowing. The external debt of the government is

divided into three: multilateral, bilateral, and private creditors. Multilateral creditors are

institutions such as the IMF, the World Bank, African Development Bank, and Fund for

International Development, as well as other multilateral development banks. Bilateral creditors

include governments and their agencies (including Central Bank), autonomous public bodies or

official export credit agencies. Private creditors include foreign commercial banks and suppliers.

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The government borrows internally through issue of bonds, sale of treasury bills and direct

advances from National Bank of Ethiopia. Treasury bills are issued by government to raise

money for short-term. A government may need money to cover salary expenses, operating and

project expenditures before its regular revenue is collected on time. Or it may issue treasury bills

to adjust the amount of money in circulation with its actual demand whenever there is

imbalance. Three kinds of treasury bills, different with respect to their maturity, are issued– a

monthly (28 days), a three-month (91 days), and six-month (182 days) bills. Bonds, in general, are

long-term written promissory agreements by which a borrower promises to pay a stated sum of

principal and interest amount on specific dates to the holder of the bond. Government bonds are

those bonds issued by the government for the purpose of financing, mainly, its recurrent

expenditure. With bonds, the interest rate is generally fixed.

3.3.4. Public Financial Administration

One of the main responsibilities of the government is to ensure an efficient and effective

utilization of public resources. Proper utilization of public resources calls for a systematic

administration of public financial resources. Proclamation No 57/1996 and regulation No 17/1997

with its amendments govern the financial administration of the government. The public financial

administration is about budgeting, execution of budget, reporting, and control of performances.

Budgeting Process in Ethiopia

Budgeting cycle consists of four roles which are budget preparation, legislative approval, budget

implementation, and audit and evaluation.

A. Executive Preparation

This includes preparation of the annual budget by public bodies according to directives of the

MoFED. Executive preparation can be divided into some stages as described below.

Stage 1: Budget Preparation:

The preparation stage has three tasks. All the three tasks would be carried out by the public

bodies who prepare their budget request. The First task is to determine the unit cost of goods and

services of developing cost build-up in the request stage. Unit cost will be determined for each

major area of service by dividing the resource invested by the output.

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The Second task in the budget preparation will be the mid-year program review. The review

involves assessment of the performance of on-going projects. As indicated earlier, since on-going

projects require resource for their completion, the amount of resource to be spent on them needs

to be examined.

The Third task in the budget preparation will be development of work plans for on-going and

new projects for the upcoming fiscal year. Once the budget preparation stage is completed, the

next step in budgeting is for public bodies to receive their budget ceiling and reduce their work

plans to fit ceilings. Budget preparation is the responsibility of public bodies.

Stage 2: Preparation of the Formula for Subsidy to Regions:

MoFED will prepare a proposal and present it to the Federation Council for the formula to be

used in allocating the regional subsidy. The federation council will then amend the formula for

the regional subsidy if it is commonly felt that the formula does not permit allocation of

resources in an equitable manner.

Stage 3: Notification of the Estimate of Subsidy:

MoFED releases to regions and administrative councils of their estimated subsidies for the

coming fiscal year. Notification of the subsidy enables regional governments to incorporate the

subsidy in their annual budget which is presented to the regional council. The notification is

issued by the MoFED to regions and administrative councils between January 9 and January 16.

Stage 4-Budget Call:

The budget call provides public bodies with their budget ceiling for recurrent and capital

expenditure for the coming fiscal year and the deadline for submitting their budget requests. It

also includes a review of the policies that affect the expenditures of public bodies, the guidelines

on treating external loan and assistance. The general guidelines for the preparation of the

recurrent and capital budget submission and detailed instruction and formats for preparing the

request for the recurrent and capital budgets is also part of the budget call. In general, the budget

call allows public bodies to start the task of formulating the budget by taking into view resource

constraints and specific guidelines of format.

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In brief, the budget call informs public bodies what their ceilings are and when to prepare their

budget requests. It is issued by MoFED to promote a common budget calendar and better

coordinate the preparation of the recurrent and capital budgets.

Stage 5- Budget Request:

The budget request begins when public bodies receive the budget call. The central task of the

public bodies during the request stage is to fit their request within the budget ceiling issued in

the budget call. To ‚fit‛ the requests two tasks have to be done by the public bodies. First, they

have to adjust their planning and programming based on resource envelope and work plans to

the budget ceiling. The original request they prepare before the ceiling has to be reviewed and

hence a change in the plan and programs for the next fiscal year is necessary. Second, they have

to prepare a justification of the cost build-up of the work plans of their projects and sub-agencies.

Public bodies are responsible for preparing their budget requests and seven weeks (February 8-

March 31) is allotted to this stage.

Stage 6- Preparation of the Recommended Budget:

It is at this stage that budget requests that exceed the ceilings are reviewed and necessary

adjustments are made in the total ceilings of public expenditure and the ceilings of public bodies.

This is done for both recurrent and capital budgets.

The MoFED prepares a recommended budget, consolidates it, and forwards it to the Office of the

Prime Minister for approval. The recommended budget will have the following four parts: an

estimate of resources; subsidies to the regions and administrative council; a recurrent budget,

and; a capital budget.

Stage 7: Approval of the Recommended Budget:

This is a stage where the budget gets approval from the office of prime minister and the council

of ministers. The approval will be finalized within two weeks because most of the comments

have already been communicated during review of capital expenditure. The four tasks involved

in this stage are:

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1. To assess the reasonableness of the resource estimate;

2. To review the total of the subsidies to regions and administrative councils and the split

between federal expenditures and subsidies;

3. To ensure that priorities established have been reflected in the budget &

4. To ensure that recurrent budgets are budgeted according to the government policy.

Any change or revision at this stage is referred to Ministry of Finance and Economic

Development and adjustments are made accordingly. Finally, the revised budget will be

approved by the Council of ministers and wait for the approval of the parliament.

B. Legislative Approval

Stage 8: Approval of the Recommended Budget:

The stages stated from stage 1 to stage 7 constitute the first part of budgeting referred as budget

preparation. Next stage of budgeting deals with legislative approval and executive


The recommended budget is draft approved budget subject to review, revision, and approval of

the parliament. It has been stated draft approved budget because it has got the approval of

council of ministers but now waiting for final decision.

Stage 9: Appropriation of the Approved Budget:

At this stage, the parliament, based on the approved budget, authorizes funds for appropriations.

Approved budget is appropriated by budget type (capital and recurrent expenditure for federal

government), and by subsidy (by region and administrative council). The approved budget and

its annual appropriation become proclaimed budget and it is published in Negarit gazeta.

Whenever, there is need to have additional fund above the approved and appropriated budget,

executive agencies must submit a supplementary budget to the parliament and get approval.

C. Executive Implementation

Stage 10: Notification of the Proclaimed Budget:

This is an initial implementation stage of the budget cycle. Public bodies are notified by Ministry

of Finance and Economic Development of their proclaimed budget in detail to the extent of line

items of expenditure.

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Stage 11- Implementation of the proclaimed budget:

In the implementation stage, the proclaimed budget is managed in terms of requests for

adjustments and monitored through financial and physical reports. The adjustments are

commonly made through transfers, virement, and Supplementary.


These are the transfers of funds between public bodies, which increase one public body’s budget

and decrease another public body’s budget. It also includes transfer of budget between capital

and recurrent items of the same public body. The transfer can be done in two different ways. The

first type is reallocation between the capital and recurrent budgets within the same public body.

Under this type, surplus funds from recurrent budget can be transferred to the capital budget

with the approval of council of Ministers. However, transfer from capital budget to recurrent

budget is strongly prohibited. The second type of reallocation is between public bodies within

the same type of budget (e.g. capital or recurrent). The second type of reallocation requires the

approval of Council of Ministers.

Virement: This is the reallocation of funds within a public body’s budget between items of

expenditures. This occurs when the amount of resource allocated to a particular activity is

relatively higher than the one allocated to another activity. It is made within a public body to

transfer within a project between items of expenditure or transfer between projects. For this type

of re-allocation, the MoFED has to approve transfers in the recurrent budget and the capital

budget. If allocation involves funding of new projects, parliamentary approval would be

required even if the appropriated budget ceiling was not exceeded.

Allotment: Once the legislature approves appropriation, the treasury does not automatically

channel the funds to the spending agencies. In nearly all governments the central budget office

apportions the funds periodically (monthly, quarterly, or semi-annually), or as needed. The

operating agencies submit plans to the central budget office as to how appropriated funds will be

used; the plans often indicate proposed expenditures for each month or quarter of the fiscal year.

The budget office may require modification of agency proposals and virtually approve

apportionment for each agency. The allotment may be a lump sum subject to restrictions
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imposed by the central budget office. Conversely, if the appropriation consists of numerous line

items, the allotment follows the same classification. Presumably, a lump sum allotment gives the

spending agencies maximum flexibility and discretion in the use of funds. Conversely, allotment

by line items would tie their hands.

Apportionment: Following the approval of allotment by the budget office, apportionments are

made within the department. This process grants expenditure authority to subunits of operating

agencies. The nature of the apportionments varies with the structure of the appropriation. The

primary purpose of apportionment is to ensure that units of operating agencies spend at a rate

that will keep them within limits imposed by the annual appropriation of the operating agency.

Supplementary: These are additional funds to a public body, which increase the total

government budget. They require additional resources and additional appropriation.

Supplementary appropriations are made after checking for the possibility of both transfers and


Mid-year Changes: As the year progresses, the budget office conducts reviews of agency

operations. One problem that often emerges is that resources in some agencies are insufficient to

meet the demand for services. In this case, one alternative for the budget office is to approve

supplemental appropriations by making request to the legislative branch.

Mid-session review of the budget discusses economic trends and how these trends affect receipts,

spending patterns, the activities of credit programs, and whatever requests and other procedures

are in place to attempt to limit the budget deficit. In any event, what is actually spent will be

different from what was originally approved.

Mid-year crises may emerge because of unfavorable revenue situation. Government budgets that

depend heavily on a single commodity export may experience severe fluctuation during the year

as the world price of the commodity fluctuates. Since personnel costs are the largest single item

in operating budgets, these costs must be curtailed when revenue receipts are below projected

levels. Freeze in personnel hiring are common in government.

Some governments have expected all employees to share in the problem by working, and being

paid for, a four-day week rather than a five-day week, thereby creating a 20% saving.

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End-of-Year Spending: As the fiscal year approaches its end, agencies will attempt to exhaust

their budgets; an agency having unexpended funds at the end of the fiscal year may be

considered a prime candidate for cuts in the upcoming budget. In addition, unexpended funds

often lapse at the end of the budget year. From the agency’s perspective, it is a now-or-never

situation for spending the available money. Another factor is that an agency might have delayed

some expenditure, saving a portion of its budget for contingencies. This delay results in hasty

spending of expenditures at the end of the year, with some spending being highly appropriate

and other utterly wasteful.

In most government organizations, spending level attains its peak towards the end of the fiscal

year. This is explained partly due to inability of the central finance and planning agency to make

appropriation available on time due to unexpected revenue problems. When revenues

anticipated to be collected turn out to be uncollectible postponement of activities occurs. The

other reason is absence of putting activities in the order of priority and accomplishing them in

the same order.

If the budgets are to be funded in gross, then the disbursement would include the retained

revenue. Retained revenue are defined as ‚own funds‛ of public bodies. The total amount to be

disbursed to a public body would be the sum of both treasury and retained revenue.

D. Budgetary Control

Internal control (i.e., the compliance of the rules and regulations, procedures, etc.) is an essential

function for every public body to ensure effective and efficient use of budget resources. The

budgetary control examines records, facilities, systems, and other evidence to discover or verify

desired information. Control can be exercised by external bodies or by employees of a public

body. Internal audits/controls are those performed by professionals employed by the

organization being audited. External audits/controls are performed by outside professionals who

are independent from the organization being audited. It can also be classified as financial

statement audit, compliance audit, and performance audit.

Financial statement audit involves examination of accounting reports of an entity to vouch for

their accuracy and being free from any material misstatement of facts. Performance audit, on the

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other hand, focuses mainly on checking that units of an enterprise are operating in line with pre-

established objectives that would lead towards achievement of goal of an entity.

Compliance audit is concerned more with ensuring that operating units of an organization are

discharging their respective responsibilities in accordance with the rules and regulations in the


Since financial statement audit has a very little significance to budgetary systems, emphasis is

made here on performance audit and compliance audit. Hence, subsequent discussions on

auditing will center on these two types of audits. In budgetary systems classification of audits

into pre-audit and post-audit received greater acceptance. Let us see them in turn.

Pre-audit: is an advance verification of legality of transactions before resources are committed on

their completion. It occurs before the government commits itself to a purchase and is used to

verify whether an agency has sufficient funds to purchase given equipment and that agency is

authorized to have that equipment. In this audit, not only the budget office but also the

accounting department or agency is involved. A pre-audit may include:

 Countersignature of documents authorizing incurrence of obligations;

 Examination of vouchers directing payment of obligation;

 Determination that obligations were properly incurred, goods were received, amounts

certified are correct, and money is available for a specified purpose.

Post-audit: is an examination of records and activities after they have already been completed. In

governmental budgeting, a post-audit is performed after appropriations are spent on various

programs and projects. A post-audit includes verification of legality of transactions and accuracy

of accounts. It is usually undertaken by an agency independent of the administration. Three

types of post-audit could be made with varying objectives.

 Verification of documents and ascertainment that receipts and expenditures have been

treated in accordance with statutory requirements. It may be directed towards

examination of pay orders issued by fiscal officers.

 Examination of transactions and their relation to the administrative rules of an agency.

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Assessment of overall efficiency and effectiveness of operating agencies in order to examine

whether the allocated resources are used economically and for the purpose approved in the


3.4. Deficit financing in Ethiopia

3.5.1 Meaning of deficit financing

Deficit, in finance, refers to the excessive public expenditure over public revenue. Deficit is

occurred when government expenditure in a particular period exceeds government source of

income due to several reasons such as expansion of government activities in a budgeted period,

decline in source of revenue, inflation, over and under estimations, etc. The gap between the

shortfall of public revenue and excessive public expenditure must be filled. The means by which

governments fill this gap is deficit financing. Deficit financing is occurred due to imbalance of

government financial structure.

Deficit is financed through different mechanism. In a wider context, countries shift their excess of

current account or capital account to finance wherever deficit exists. Since deficit financing is a

wider conceptualization that affects the overall economy of a nation, macroeconomic alternatives

such as taxation, printing money and borrowing financing sources are key factors to make

decisions of filling the gap in the fiscal policy. Internationally, money financing is proved as


Deficit financing through taxation and borrowing from the public and commercial banks is

considered as non-inflationary as public expenditure replaces private expenditure. Hence,

borrowing and taxing are ranked as best deficit financing tools.

3.5.2 Deficit financing objectives

Deficit financing has been recognized as an important role in fiscal policy on account of increases

in public expenditure on various accounts while public revenues remain insufficient to cover

government spending.

There are several reasons why deficit financing is important including the following ones.

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i) To finance wars: many countries are want to be equipped with modern weapons and build up

their military. They also engaged in very expensive wars. This demands huge resource and

hence, deficit financing has been found to be the simplest and quickest method to finance

military and war expenditures.

ii) To reduce unemployment: during bad economic times like deflation, unemployment rate

increases as the economy unable to create jobs. Thus, public expenditure increases to stimulate

the economy and create more jobs for jobless citizens. Hence, deficit financing is advocated as

an important tool of solving the problem of involuntary unemployment during depression.

iii) To promote economic development: in developing countries, one of the vital roles of public

finance is accelerating economic development. Such practices demand huge resources

mobilization due to huge spending. Public investments in infrastructure are essential to attract

more foreign investors for huge capital accumulation. Thereby, deficit financing can go a long

way in promoting economic development in underdeveloped countries.

iv)To finance strategic plans: in developing countries like Ethiopia where several development

plans are adopted at several times to ensure overarching development, deficit is obvious. We

can cite the Growth and Transformation Plan (GTP) which requires huge resource

mobilization. To finance such plans, deficit financing exists.

v) To serve as an alternative tool: underdeveloped countries suffer from low taxable capacity

and low savings. Hence government's ability to raise resources gets constrained. Therefore

there is no harm in resorting to deficit financing as an alternative source of mobilizing

resources besides taxation and public borrowing.

3.5.3. Effects of Deficit Financing:

Deficit financing has both positive and negative effects in the economy as under:

1. Inflationary rise in prices: The most serious disadvantage of deficit finance is the

inflationary rise of prices. Deficit financing increases the total volume of money supply.

Unless there is proportional increase in production this can lead to inflation. When deficit

financing goes too far it becomes self-defeating. There was inflationary pressure during the

decade due to deficit financing.

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2. Effects on distribution of wealth and income: The real income of wage earners gets reduced

and that of entrepreneurs/ businessmen increased, leading to distribution of wealth in favor

of business class

3. Faster growth: Country is able to implement the developmental plans through deficit

financing thereby attaining faster growth.

4. Change in pattern of Investment: Deficit financing leads to encouragement for investment in

certain fields like construction, luxury consumption inventory holding and speculation. This

may lead to investment in undesirable fields.

5. Credit creation in banks: Inflationary forces created by deficit financing are reinforced by

increase credit creation by banks.

Among various fiscal measures, deficit financing has been assigned an important place in

financing developmental plan and various developing countries including Ethiopia resort to

deficit financing to meet budgetary gaps.

3.5.4. Deficit financing practice in Ethiopia

Deficit financing in Ethiopia was mainly resorted to enable the Government of Ethiopia to obtain

necessary resources for the plans. The levels of outlay laid down were of an order, which could

not be met only by taxation or through a revenue surplus. The gap in resources is made up

partly through external assistance. But when external assistance is not enough to fill the gap,

deficit financing has to be undertaken. The targets of production and employment in the plans

are fixed primarily with reference to what is considered as the desirable rate of growth for the

economy. When these targets cannot be achieved through resources obtained from taxation and

external borrowing, additional resources have to be found. Deficit financing is the easier option.

It is important to emphasis the fact that deficit financing cannot create real resources which do

not exist in the economy.

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